2020 views and outlook
To recap on last year’s views I said there were three things to watch for in 2019; Brexit, US China relations and US interest rates. It wasn’t rocket science saying these were the important things to watch out for, and frankly they have been the key drivers of returns in 2019. I’m not sticking my head above the parapet too far to say these three factors will be as important for investors in 2020.
Interestingly when I penned this outlook 12 months ago, I said that there would probably be two rate increases from the Fed in 2020 – it was amazing how quickly their stance shifted towards easing with three rate cuts and the end of quantitative tightening. Finally, I also said that the FTSE would finish at 7750 at the end of 2019 – if there is a Conservative majority next week this could still happen! However the point I was making was that returns were going to be dull.
Three things to watch for in 2020
Being boring, and repeating what I said above, it is very similar to 2019’s watch list. With a US Presidential election in November, President Trump will want a trade deal with China sorted. An interesting statistic I picked up recently indicated that incumbent presidents have always been re-elected as long as there isn’t a recession in the previous two years (see table below); President Trump will do everything he can to ensure there is no recession in 2020. The flip side of that is that 6 out of 7 times there has been a recession the president has not been re-elected. We appear to be inching towards a trade deal – in fact the next key date is December 15th when new tariffs are set to be imposed. Whether they are imposed will show the likelihood of a deal next year.
Interest rates, rather than specifically US rates, are the second thing to watch for in 2020. Developed market central banks are in cutting territory – however the impact of those cuts is lessening. The US has reversed almost 40% of the QT (quietly restarted QE) it delivered and cut rates three times in 2019. Many consider monetary policy to be a failure, but there are some who believe it has worked, just with a longer lag than was anticipated – don’t forget we have full employment in the UK, US and Japan. Emerging Markets are doing conventional monetary policy, whereas developed markets are unconventional. Which is having more impact? Negative rates seem set to stay in Germany and Japan – is it only time before they creep into the US and UK? If they do then this will undoubtedly fuel further bond and equity market rises. The US tightened too much in 2018 leading to panic in the final quarter, will they over stimulate now leading to inflation?
Finally to Brexit. I’ll make the assumption whilst writing that the polls are correct and there will be a Conservative majority. If this is correct, then we will leave the EU by the end of January 2020. However that isn’t the end of Brexit’s impact on investor’s portfolios. With a trade deal to be done, there will be more uncertainty and volatility as the Tories self-imposed end of 2020 deadline looms for the trade deal. The closer we get to that deadline the more sterling will move on worries about no deal. As we have seen over the past few years, sterling has a big impact on the FTSE and therefore just because the first part of Brexit is almost completed don’t assume it’s all plain sailing from here.
I’ll start with a chart. Germany avoided going into recession in 2019, and actually it looks as if things are picking up. The chart below shows manufacturing orders and sentiment. It looks as if orders are picking up with sentiment lagging. This is crucial if Europe is to pull itself out of a slump as Germany is the manufacturing hub.
Global equities are neither cheap nor expensive on average. There are pockets that are cheap and ones that are expensive. We are late in the economic cycle but central bankers are doing everything to prolong this, probably as they fear that a recession would be disastrous due to high levels of debt globally. The bull market has further to run. The US always looks expensive, but recent economic growth numbers look far better than most countries, so arguably the premium rating is justified. According to Bloomberg, the S&P 500 is on a PE of 20.5, the FTSE 100 on 17.3 and the Euro STOXX 50 is on 19.5. Emerging markets look good value still, as do many Asian markets and for long term investors this is still an asset class I favour.
The UK Market
It doesn’t really matter what metric you look at, the UK market is cheap. I have included a chart above from Montanaro Asset Management showing the gap between the dividend yield and the gilt yield. It’s the widest it has been since the reign of Queen Victoria. International investors have abandoned the UK over the last few years resulting in the current cheapness of the market. Assuming a Tory majority and Brexit happens, this undervaluation should narrow sharply over the coming months. Obviously a stronger sterling will have an impact on overseas earners, but the rise in domestic stocks from historically cheap levels should more than offset this. On the assumption of a Tory majority, UK shares could be in for a good 2020.
Using the Tory majority assumption, sterling should recover some of the ground lost over the last few years. Some say sterling is up to 10% undervalued, whereas others say 5%. Assuming a rebound, this will depress FTSE earnings, as over 70% of these come from overseas, and will have an impact of overseas investments too.
It is hard to get excited about the outlook for fixed interest in 2019, sorry that should say 2020! Actually 2019 has been a good year for bonds as prices have risen sharply on the back of 3 US rate cuts and further ECB stimulus. It looks like the US is pausing for a while now to see the impact on the economy but the ECB are virtually underwriting lots of the investment grade market. Developed market government bonds look decidedly unattractive today – however, if the US and UK follow Japan and the EU in using negative rates there could still be huge upside. High yield looks risky, we are definitely late in the economic cycle meaning defaults will start increasing – are you really getting paid for the risk being taken? Emerging market bonds look interesting, the fragile five seem less fragile and debt and current account deficits in many countries are the envy of many developed market countries. By the way there is approximately $13 trillion of negative yielding debt globally, of which almost $1trillion is company debt.
Similar to bonds, commercial property also looks fairly anaemic. Prime property has continued to change hands with low yields, but the high street has found very few buyers. Industrial and logistics have continued to be a very bright spot, but prices are so high in many cases it is hard to make a case for investment. Property continues to act as a diversifier but the next few years is likely to see little or no capital growth and therefore coupon clipping the income at best. With many open ended UK direct property funds holding upwards of 25% cash, returns could be in the low single figures percentage range for a while.
A continued bright spot has been infrastructure investment; indeed it has been a key theme in portfolios for over a decade now. Some might say it’s not, but I consider it a distinct asset class. Appetite from both UK and international investors remains strong, just look at the fundraising from some of the UK listed infrastructure trusts in 2019 for proof. If we are to continue in a low rate, low growth environment then infrastructure delivering stable returns with some form of inflation linkage will be in demand.
Gold has had a good run in 2019 with a low $1226, a high of $1560 and a current price of $1472. Incidentally the low point was at the turn of the year. As real yields fall (rates after inflation), gold typically does well. We’ve had three US rate cuts in 2019 and a dose of political uncertainty so it is no surprise gold has had a decent year. Quite often gold performs well two or three years in a row, so on that basis 2020 could be decent.
A 2020 FTSE prediction
Last year I said that the FTSE would end 2019 at 7750. A mini Santa rally with a Tory majority and I won’t be too far off. I’m actually going to stick with a similar figure for the end of 2019, 7850, as domestic UK stocks rallying will be slightly offset by a pullback in overseas earnings.
With thanks to Montanaro Asset Management, Man GLG, and Heartwood for the charts.
Ben Yearsley December 2019
This article represents a personal view from Ben Yearsley, and is based on his opinion of economic data from the UK and across the globe. It should not be used for investment purposes and does not constitute advice. For investment advice please refer to your financial adviser. No party should act or refrain from acting on anything contained in this material. Relevant primary materials should always be consulted at all times for all purposes. No statements or representations made in this material, document or at the presentation are legally binding on Shore Financial Planning (Plymouth) Ltd or the recipient and no liability is accepted in connection with this material. This article may not be reproduced or circulated without prior permission. Issued by Shore Financial Planning (Plymouth) Ltd, authorised and regulated in the UK by the Financial Conduct Authority.
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